FDIC's Bair pushes aggressive mortgage plan

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FDIC Chairwoman Sheila Bair

NEW YORK (CNNMoney.com) -- In a surprise move, FDIC Chairwoman Sheila Bair Friday unveiled details of her plan to have the government help delinquent homeowners.

There are two key elements to the proposal.

First, housing payments for delinquent borrowers two months or more late would be reduced to 31% of gross monthly income.

To get there, mortgage rates could be set as low as 3% for five years, before increasing at an annual rate of 1 percentage point until they hit the prevailing market rate. Loan terms could be extended as long as 40 years.

Second, to encourage servicers and investors to participate, the government would share up to 50% of the losses if a borrower who had been helped ended up in default anyway. The risk of re-default had been one obstacle to getting lenders on board with systematic modification plans.

In addition, the FDIC would pay servicers who process mortgages $1,000 for each re-worked loan.

The plan is expected to initially help 2.2 million borrowers get new loans; after some borrowers re-default, 1.5 million would ultimately keep their homes, the FDIC estimated.

The plan would cost an estimated $24.4 billion, which Bair has said could come from the $700 billion bailout Congress approved last month.

"It is imperative to provide incentives to achieve a sufficient scale in loan modifications to stem the reductions in housing prices and rising foreclosures," the Federal Deposit Insurance Corp. said in a statement Friday.

A record 1.2 million homes were in foreclosure during the second quarter of 2008, according to the Mortgage Bankers Association, and the problem is only expected to get worse. Some estimates say another 2 million families could lose their homes to foreclosure in the next two years. This flood hurts the national economy as well, depressing home values and consumer spending.

Unless Bair's proposal gets the Treasury Department's blessing, it would have to be approved by Congress or wait for review by the Obama administration.

Bair's move Friday sets up a public power struggle not often seen within an administration.

The FDIC chairwoman has long wanted the government to take a more active role in helping troubled homeowners. She initiated a similar plan at IndyMac, one of the largest mortgage lenders, after the agency took it over in mid-July.

Bush administration officials, however, have resisted her efforts, instead unveiling a plan Tuesday to streamline modifications of loans held or guaranteed by Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500).

Treasury Secretary Henry Paulson has backed away from supporting Bair's plan. A Treasury spokeswoman Friday referred to comments Paulson made on Wednesday.

"We must be careful to distinguish this type of assistance, which essentially involves direct spending, from the type of investments that are intended to promote financial stability, protect the taxpayer, and be recovered under the TARP legislation," he said.

Bair, however, is optimistic.

"I don't think it's dead," Bair told National Public Radio on Friday. "I think we're still talking. [Paulson] didn't close the door completely. It's just where the money comes from is really the issue we're debating."

Congressional Democrats, however, have continued to press for increased assistance to homeowners. They have publicly backed Bair, which could give her proposal the push needed for adoption.

Executives from the nation's largest financial institutions told the Senate Banking Committee Thursday they too support Bair's efforts in combating foreclosures.

The committee's chairman, Sen. Christopher Dodd, D-Conn., has long argued that both the government and servicers need to do more to help distressed homeowners. "All of these measures frankly have not produced anywhere near the results we hoped they would," said Dodd, adding it's "terribly regrettable" that the Paulson is not behind her plan.

Acknowledging that many Americans who are paying their mortgages may be angry that their neighbors are getting help, Bair said that foreclosure hurts everyone in a neighborhood by bringing down home values.

"These escalating foreclosures are creating more and more downward pressure on home prices, which is having a very negative impact on our economy," Bair said on National Public Radio Friday. Americans should realize "it's in [their] economic self-interest to get this situation stabilized."

Unlike some other government programs, the FDIC proposal would not reduce the principal to bring it in line with the home's current value. Instead it would allow part of the principal to be deferred free of interest to the end of the loan.

Borrowers who sell or refinance before paying off the debt would have to pay the principal at that time or work out a short-sale with the bank, where the servicer agrees to forgive the outstanding balance.

Some consumer advocates consider principal reduction key to assisting borrowers in areas where property values have plummeted, leaving many with mortgages greater than their home's worth - or "underwater."

With the Hope for Homeowners program implemented last month, mortgages would be written down to 90% of the home's current market value and borrowers would be refinanced into 30-year fixed-rate mortgages insured by the Federal Housing Administration.

The FDIC's program, on the other hand, would not be as beneficial for underwater homeowners. For situations where the mortgage is worth more than the home, the government's loss-sharing arrangement would gradually decline to 20% before ending for homes where the loan-to-value exceeds 150%.

The loss-sharing arrangement would last for eight years. Only mortgages below the conforming loan limits for Fannie Mae and Freddie Mac - up to $625,500 depending on location - would qualify.

The agency is not pursuing principal reductions because it can achieve affordable monthly payments without them, said Andrew Gray, FDIC spokesman.

Also, it's easier to convince investors to agree to a workout if the loan balance is not changed. When the principal is lowered, the value of loan modification over foreclosure is reduced.

At IndyMac, agency officials have already modified 5,000 troubled mortgages, achieving affordable payments through interest rate modifications in 70% of the cases. Another 20,000 delinquent borrowers are in the process of having their income verified.

Taking over IndyMac allowed the FDIC to put into practice its call for a streamlined system to mortgage modifications, a move other servicers have since followed. Until then, loans were being adjusted on a case-by-case basis, which overwhelmed servicers and increased the flood of foreclosures.

Payments on the modified IndyMac loans, which are being adjusted to between 31% and 38% of income, are lowered by $380 on average, Bair told lawmakers last month.

A total of 65,000 borrowers, or 10% of IndyMac's loan portfolio, were delinquent when the government took over. The agency is reaching out to another 20,000 delinquent borrowers, while the remaining 20,000 borrowers are not eligible for help for a variety of reasons, including that they are investors who don't live in the home or owners who have already turned in the keys.

The agency is adjusting both loans that IndyMac owns and those it services that have been bundled into securities and sold to investors. According to the FDIC, officials are not having trouble convincing investors - who are often accused of blocking modifications - that they'll recover more if the loan is adjusted rather than if it goes into foreclosure.

"You demonstrate to investors that modifications are the better alternative," Gray said.

Consumer advocates have repeatedly said the economy and housing market won't recover until more is done to help stem the tide of foreclosures. They don't feel the current foreclosure mitigation efforts undertaken by the Bush administration and by banks are sufficient.

The FDIC plan, however, will do more to help troubled homeowners and do it more quickly, they said.

"Chairman Bair's proposal has the potential to have an impact of the size and scope necessary to get ahead of the foreclosure crisis and put the economy back on its moorings," said John Taylor, head of the National Community Reinvestment Coalition, an association of more than 600 community-based organizations.

Several banks, including JPMorgan Chase, Citigroup and Bank of America, have recently announced plans that would also modify mortgages so that monthly payments are between 31% and 38%, depending on the servicer. They project these efforts will assist nearly 1 million delinquent borrowers.

The government, meanwhile, has pushed lenders to do more, mainly through voluntary measures, such as the Hope for Homeowners program.

On Tuesday, federal officials announced a mandatory program to modify delinquent mortgages owned or guaranteed by Freddie and Fannie. But housing counselors said this program wouldn't address the vast majority of subprime loans, which are outside of Freddie and Fannie's reach.

At Dodd's hearing Thursday, several community activists voiced their support of Bair's efforts, even before the details were announced. "The Sheila Bair-FDIC proposal is just an absolute no-brainer," said Martin Eakes, head of the Center for Responsible Lending. "There's just no reason why we shouldn't get it done in the next week."